Is Employer-sponsored Voluntary Term Life Insurance a Good Buy? – Case Study #6

I just finished a case with an officer of a large company who had most of his life insurance through his employer. They paid for an amount equal to 2X salary; he paid for another 5X. Like a convenience store, employer sponsored life insurance makes it easy to buy: proximity, no full blown physical, check the box, and payroll deduction. However just like a convenience store, it’s not cheap.

Often 2X or 3X salary are offered “guarantee issue”, meaning there is no health screening at all. This invites higher risks. Those who sign up first often have an insurability problem – diabetes, DUI’s, obesity, smoker, etc. Insurers call this adverse selection and to provide for the inevitable higher claims they must charge more.

Even higher levels of coverage require only an abbreviated health questionnaire, far less rigorous than for an individual policy with its paramedical exam, blood testing, requesting medical records, etc.

Therefore rates charged under voluntary plans at work are always higher than favorable rates for an individual policy. I don’t just mean higher than the best risks, but also higher than the mild-hypertensive, slightly-elevated-lipids, or two-speeding-ticket risks.

If you have a major health issue, employer-sponsored life insurance may be a good buy, but if you don’t you can probably do better.

Here are some other advantages of individual policies. Most employer sponsored term plans have five-year rate bands with rates increasing at age 35, 40, 45, 50, and so on; most individual term policies have level premiums for 10, 15 or 20 years. Term insurance through work usually ends at retirement or termination of service; an individual policy goes with you regardless of employment.

One touted advantage of group life insurance is that $50k or less can be paid with pretax dollars. This small tax advantage is usually more than offset by the higher premium rate.

The popularity of employer sponsored plans is understandable. A new employee dealing with an avalanche of paperwork finds it easiest to check the box without fully understanding alternatives. Because it’s then automatically deducted from their paycheck before even seeing it, this out-of-sight-out-of-mind but ill-conceived financial tool can roll on for decades.

Remember the step that precedes all this is choosing the appropriate amount. Though buying in multiples of salary is a reasonable way for an insurer to administer a group life plan, it’s not the way a consumer should choose an appropriate amount of life insurance.

Also remember the new policy should be approved and in force before discontinuing voluntary insurance at work. Many people think discontinuing group term can only be done once per year during open enrollment period, however this time restriction does not apply to group life insurance over 50k .

After an amount is determined, then the most competitive individual term policy should be chosen, considering the nuances of your health. A duration needs to be chosen. If you need help in the process, that’s what we do

An Important (often overlooked) Feature of Term Life Insurance – Case Study #5

I’m currently doing a Life Insurance Checkup for a couple in Tennessee that underscores an important cost aspect of level term life insurance…but it’s not the premium rate.

The first step in a Checkup is rightsizing the size policy. This couple, like many, used a rule of thumb (a multiple of income plus debt) promoted by Dave Ramsey, whom I highly respect. However rules of thumb are a crude way of giving wholesale advice. I prefer fine-tune efficiency which comes best through customization. The difference can be dramatic, as it was in this case.

He is a veteran construction manager who had already retired from one employer and had a pension with a significant monthly survivorship benefit for his wife. (This is tantamount to a lot of life insurance.) There are no kids in the picture, they have a reasonable 401(k) and a $750K life insurance policy on him with Allianz. Their emphasis is on debt repayment and they don’t want to spend unnecessarily on anything, including life insurance. After reviewing her income needs and their assets and debts, they think the appropriate insurance need is $350K rather than $750K. How do we best make this adjustment?

The easiest way would be to reduce the current policy. Allianz is a strong company, ranked AA with Standard & Poor’s. He bought this 20 year level term policy four years ago when younger, so a comparable policy would cost more today at his older age. Also, if he had had a health decline it would put him in a higher rate category.

The problem is, though many companies allow a policy reduction during its lifetime, Allianz does not. Some allow it only once during the policy’s life and some allow multiple times. Since Allianz doesn’t at all, it forces him to consider a new (appropriate amount) policy, at an older age, subject to insurability, losing the reserves of the old policy, new contestability period, new commissions, etc.

Let me take a moment to emphasize an important aspect of insurance planning: the amount of insurance you need is rarely static. For most people it reduces as assets grow (401(k), savings, etc.) and liabilities diminish (mortgage is repaid, young children mature, etc.) So the thought that you’re going to need the same amount of insurance for 20 years is probably unrealistic. Yet many people buy such policies and keep them at the original amount for decades. This accounts for the invisible waste of much premium, as people imperceptibly become over-insured. Few people reassess (even if it’s only every 5 to 10 years) their insurance needs…though it’s usually profitable to do so.

Reducing term policies (almost a relic of the past) recognized this dynamic: the amount of insurance needed declines over time. Today’s most competitive policies (level term policies) do not. Thus it’s incumbent on the consumer to make his own adjustments. To do so your policy must permit it.

So when you’re buying a term policy, be sure to find out if the policy owner can reduce its amount at least once during its life. Another possibility is buying multiple policies for different durations: for example a 20 policy for $350K, and 10 policy for $400K. This automatically schedules a decline in insurance as your needs likely decline. The problem with this is that you don’t know the rate at which your needs will decline. Another problem is poorer pricing on multiple/smaller policies.

We tend to think that buying a good term life policy is simply a matter of buying a strong company with low premiums. However there are other important features. The ability to reduce the policy at least once during its life is one of them.

The fine art of choosing an amount of life insurance: Case Study #4

Johann S. Bach once said, “All one has to do is to hit the right keys at the right time and the instrument plays itself.” It’s mechanical, right? I had a CPA friend make the same observation when I first told him about my idea of a life insurance planning service: just devise a computer program to do it. Many insurance companies have done just that… and the recommendations they spit out compared to mine are as different as night and day. Why?

While there is an underlying element of mathematically measurable data, we are also dealing with people with a variety of human emotions and experience, all of which color their thinking. Blending these two components together is done better with experienced judgment, just as the piano is best played by the experienced.

Yesterday I finished a case with a South Carolina engineer. It started like this:

My present plan is to get a term policy that will bridge the gap until Beth would qualify for Medicare and Social Security. My thoughts are that I would get a 15 year fixed rate term policy for $500,000. I would like to get assistance in evaluating if this is the right type of coverage to get and if this is adequate in duration and amount and where is the best place to purchase it.

It ended like this:

I looked over the Life Insurance Needs assessment you prepared and I have a real peace about buying the $250k life insurance. For me, the $5800/month [income goal] looks good. This gives Beth about 15% more than I had calculated her needs would be.

What he initially wanted costs $1500 per year; what he ended up with costs $700 per year. What transpired in between? It was a combination of financial analysis (clarifying survivorship benefits from his pension, and the way assets were growing and liabilities were being quickly discharged, and the low probability of death within the next 15 years) along with addressing what was emotionally driving him.

Let me make a couple of observations:

  • He would not get this advice from an agent. They promote more, not less.
  • The consequence of this upfront decision has 10 times the effect of getting a good rate.

On the other hand I got a recent inquiry from another person wanting a quote on term insurance. Apparently he misunderstood the service I provide and when I ask him to complete the questionnaire for the needs assessment, he balked; he “just wanted a quote”. The presumption is he knew how much and what type he needed, so could not benefit from my input in this respect. This is getting the cart before the horse and overlooking the greatest opportunity for price savings, not over-buying to begin with.

Shopping rates is important, but it’s not the starting point. If that’s where this engineer had started he might have felt shrewd while straining at gnats, but would have been unwittingly swallowing a camel. Instead he started with experienced counsel, as Proverbs 20:18 commends. While the second guy saved a consultant fee, the engineer most likely came out way ahead.

Notice that I don’t tell people what to buy. Rather he said, “I have a real peace about buying the $250k life insurance.” I just raise their awareness of facts and considerations that are overlooked in most insurance sales settings. I try to calm their fears, as per Luke 10:41 and 12:25, so they aren’t emotionally off balance as they decide. Then they make their decision. It’s a combination of financial analysis and emotional counseling- it’s an art.

Value (Routinely) Added – Case Study #3

I finished a case this week that bears out an important point: many who come to me for insurance advice walk away with something they didn’t expect; frequently it’s more valuable than what they came for.

This client is a UPS pilot considering long-term care insurance and wanted me to look over his life insurance as well. Like a lot of pilots he had a military background and already connected with a good insurance company, USAA. He got a 20 year term policy at preferred rates 6 1/2 years old so he could not improve upon it. Then the question of long-term care insurance became the focus.

As we reviewed his overall financial picture, which is something I always do, his most glaring deficiency was using a home equity line of credit (HELOC) to buy his house. He did not currently have any equity. Furthermore, he had a $30K loan from USAA at 3.25% and the cash was just sitting there as an emergency fund. It made him feel comfortable, though he almost never used it. He had a very high monthly take-home paycheck, and like a lot of high income people he had gotten a little loose in his spending habits.

My first recommendation was to pay off this unnecessary loan which was costing him over $80 per month interest. Recommendation number two was to carefully track all expenses for his two months to reveal where his money was going and what could be cut out to build up his emergency fund. His debt service for the USAA loan was $450/month which we committed to build the emergency fund with the goal of quickly growing it to one-month’s disposable income. After this he will pay off 20% of the HELOC loan so he can get permanent financing on his house and not have to pay private mortgage insurance.

We put the long-term care insurance on hold (see Debt-Free is Stronger than Well- Insured post) until we get on a sound budget and debt repayment plan. Interestingly USAA discouraged him from repaying the loan even though he rarely used it. (They have an agenda too.) If he has an emergency that exceeds his currently-too-small emergency fund, he can put it on a credit card. No sense paying interest to have a fund for an emergency that may never occur.

So the agent promotes long-term care insurance (a low priority); USAA promotes an (unnecessary) loan, and that’s the nature of commerce: everyone is trying to get him to buy something, when the real secret to his financial advancement is to cease buying anything (insurance included) while he pays for that which he has already bought (his house).

This client got a benefit he didn’t expect and will receive a 160% annual after-tax return on the fee he paid me just for the debt repayment idea, aside from another handful of ideas.

Debt-free Is Stronger than Well-Insured Case Study #2

 

Clients typically have two or three primary goals, each of which is in tension with the others: they may want to be debt-free and save for retirement, or they may want to have adequate insurance while investing adequately too.

The nature of economics is the distribution of limited resources, and every dollar spent on insurance means one less dollar available for debt repayment.  Each of these goals may strengthen you financially and many can be done simultaneously, but the resources that go to one cannot go to the other.  The real question is often which should be emphasized, and which should be deemphasized.  From this tension, we get the title of this blog.

Being well-insured has a possible advantage:

  • if the precise event insured occurs, proceeds will be paid.

However, being well-insured also has risks:

  • most term policies expire before the insured does, so much premium is wasted.
  • This means that every $1 spent on insurance tends to yield less than $1. Most people pay more into insurance than they get out of it.

Being debt-free has a guaranteed advantage:

  • saving interest.
  • Regardless of which contingency arises (death, disability, or losing a job), it helps to not have debt payments.

Being debt-free does not have the risks of carrying insurance cited above:

  • you always save money, regardless of what contingencies materialize in the future.
  • every dollar spent on debt tends to save a $1.20, after accounting for interest saved.

For example, many people buy insurance and then lose their jobs… to discover insurance doesn’t help at all.  Insurance is often like France’s Maginot Line, not only ineffective but also so expensive to maintain that it results in underfunding other priorities.  On the other hand, those who are debt free can better weather a variety of financial storms: disability, death, layoff, shrinking real estate values, etc.

How does this translate in the real world?  I’m working with a couple both about 50 years old with two independent children.  Husband and wife each earn about $70,000 and their chief concern is a $200,000 mortgage.

Currently they have term life insurance of $450K on him and $400K on her.  Their goals are to pay off debt, save for retirement, and optimize their insurance.

How much LI should they carry?  What about $250K each, just enough to pay off the mortgage and bolster the emergency fund?  The survivor is debt-free, gets a $50,000 emergency fund, and has a reasonable ongoing salary.  The wife (often more security conscious) may want $350K on her husband.  We can always justify more, but that means less for debt repayment.  A major tape running in the back on my mind is that 95%+ of term policies end up in the trash can anyway.

You don’t get this emphasis from a sales agent and this couple’s decision will largely hinge on their emotional comfort with an amount reduction.  Some don’t feel comfortable reducing coverage and I respect that.  However at least they get the nudge toward what’s likely provide the best long-term return.  Being debt-free is some of the best insurance you can have.